By the time you approach retirement age, the bulk of your investment wealth may be tied up in your 401(k) and other qualified retirement accounts.

If you want to use that money to buy or launch a new business for yourself, you could face a big tax bill. Withdrawals from a 401(k) plan, except for the Roth variety, are normally taxed as ordinary income, and taking a substantial distribution in any given year could even push you into a higher marginal tax bracket. What’s more, if you’re still under age 59½, you’ll generally be subject to an additional 10% tax penalty.

To get around that problem, some would-be entrepreneurs are using a little-known strategy known as a ROBS plan. The initials stand for “rollovers as business start-ups.” (Also see: Using Retirement Funds to Fund Startups.)

How a ROBS Plan Works

With a ROBS plan, you don’t actually withdraw money from your 401(k), so you don’t have to pay income tax on it. Instead, you follow a series of steps that will ultimately allow you to roll your money, tax free, into a new 401(k) plan that you can then use to fund a business.

The steps include creating a C corporation, with yourself as the lone employee, then opening a new 401(k) plan for that corporation. The new 401(k)’s terms will include a provision that allows participants (meaning just you, in this case) to invest all of their contributions in company stock. You then roll your old 401(k) into the new one and direct that your money be invested in your corporation’s shares. After that, you can use the funds to buy a business, such as a franchise, or start one of your own, without owing tax on that money.

If this sounds complicated, it is. The IRS reportedly scrutinizes these arrangements closely, and if it believes your only motive in establishing a ROBS plan 401(k) is to dodge taxes on your former 401(k), you could end up having to pay tax on the entire amount of the rollover. So a ROBS plan isn’t to be entered into without expert – possibly expensive – guidance from a CPA or other tax professional who has a background in this area. ROBS 401(k) plans also have paperwork-filing requirements that you’ll need to follow every year.

Risky Business

The IRS paints a less-than-optimistic picture of ROBS-funded businesses, based on its own 2010 study that looked at a diverse assortment of them. “While some of the ROBS were successful,” the IRS noted, “many of the companies in the sample had gone out of business within the first three years of operation, experiencing significant monetary loss, bankruptcy, personal and business liens, or had their corporate status dissolved by the Secretary of State (voluntarily or involuntarily).”

Perhaps the most fundamental downside of a ROBS strategy, however, is that you’ll be risking your retirement savings – or a substantial chunk of them – on your new business. Even if you believe your business plan to be sound, bad things happen, and countless new enterprises fail every year. If nothing else, you’ll be giving up one of the key benefits of a typical 401(k) plan: the diversification that comes from investing in many different companies instead of just one, even if it’s a business that’s near and dear to you.

Bear in mind, too, that if your goal is to launch a new business in retirement, you may have other sources of capital you can draw on, including bank financing or a U.S. Small Business Administration loan. (For more, see: Expanding Your Small Business with an SBA Loan.)

The Bottom Line

The little-known ROBS plan offers a tax-free way to start or buy a business using the money you’ve saved for retirement in your traditional 401(k). But the plans can be costly and complicated to set up and, most important, you could be jeopardizing your financial security during retirement. (Check out our tutorial: Starting a Small Business.)

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